More about Planswell
Build your free plan in 3 minutes! Start now

ETFs vs. Mutual Funds: Which is the best investment tool for you?

Since their inception, mutual funds have dominated the investment industry. To date, Canadians have approximately $1.53 trillion of assets invested in mutual funds. Perhaps you yourself have purchased them from your bank, a financial advisor or even as part of a retirement savings plan offered at work.

However, as the investment industry changes, more and more Canadians are considering investing their money in exchange-traded funds (ETFs) are beginning to take over. So what’s happening? Why are Canadians seeking out different investment vehicles? Let’s start with a brief history of investing to get us started.

 

Cigar-smoking stock brokers

Throughout most of the 20th century, investing in the stock market was reserved only for the wealthy. This group of upper-class people would hire stockbrokers to analyze which stocks and bonds they should purchase or sell, paying a commission on every transcation.

This approach to investing worked just fine during that time, as the world was a simpler place.  A knowledgeable and savvy stockbroker could likely invest in a promising oil or railway company and have successful returns. Of course, their clients were paying incredibly high commission feeds, however due to their wealth and the exclusiveness of investing in the stock market, no one truly was bothered.

 

Enter the general public

Around the 1960s, a little-known investment concept started to gain popularity. Enter mutual funds, created by pooling the money of the middle-class together, so that a “super-stockbroker,” known as a Portfolio Manager could manage it for them en-masse.

The clients would be charged the usual trading commissions, plus a portfolio management fee. These high fees could add up to hundreds of thousands of dollars over a client’s lifetime.

Despite the high costs, mutual funds took off in the 1980s and1990s. Markets were booming, so the fees weren’t really noticed or challenged. Billions of dollars flowed into the funds. The middle-class made money, and mutual fund companies made grew their fortunes.

However, somewhere in the early 2000s, things started to change. The dot-com bubble, Enron scandal, and financial crisis meant stock market returns were no longer as easy to come by. People started to compare what mutual funds were charging versus the returns they were generating, and it was clear that something wasn’t adding up.

 

The end of the party

it’s impossible to predict which manager will outperform in any given year,

More than a century after the iconic Dow Jones Industrial Average (also known as the Dow) was created, Wall Street was beginning to look like a myth. The data showed that, almost without exception, investors could have done just as well by purchasing one share of every company, then by paying high-priced experts to try to pick winners.

It turned out that over time, the fees that the experts charged tended to be exactly the same amount by which their clients would come up short.

You may be asking yourself, “what does all this mean?” Let me explain. Say the Dow, which tracks 30 of the largest companies in America, went up by 10%. You could have bought all 30 stocks and made 10%. Alternatively, you could have paid a mutual fund manager 2.25% to try to beat the Dow, but statistically, they will have ended up with the same 10% return. The catch is you would have only kept 7.75% after fees.

Yes, there are exceptions. Sometimes mutual fund managers have stellar years. Some may have two or three great years in a row. But it’s impossible to predict which manager will outperform in any given year, and none have been able to sustain a lasting edge according to the current body of research.

 

An ETF revolution

Exchange Traded Funds, or ETFs, are built on this insight. Rather than trying to select winning stocks, they aim to represent all of the stocks in a given market. And rather than charging Rolls Royce-level fees, they aim to keep costs to a minimum – just a small fraction of mutual fund fees.

Here’s everything you need to know at a glance:

 

Mutual FundsETFs
StructureYou purchase units of a mutual fund along with many other investors. A Portfolio Manager attempts to pick winning stocks or bonds.You purchase shares of an ETF on the stock exchange. Each share represents an underlying index, such as the S&P 500 for U.S. stocks or the S&P/TSX for Canadian ones.
FeesThe average Canadian Equity mutual fund charges 2.25% per year. The average Canadian Equity ETF charges 0.22% per year.
Result Research shows that mutual funds can cost the average Canadian family $300,000+ in extra fees. The money you save with ETFs can make it easier to sustain your lifestyle now and in retirement.

  Calculating ETFs vs Mutual Funds

Don’t just take our word for it, use our calculator below to calculate and compare investment management fees between Mutual Funds and ETFs.

 

 

Here at Planswell, we recommend our clients to invest their money in ETFs. You work hard for your money, it should do the same for you.Perhaps Warren Buffett, one of wealthiest men in the world said it best when he gave this instruction to trustees of his multi-billion dollar estate:

“My advice to the trustee couldn’t be more simple: Put 10% in short-term government bonds and 90% in a very low-cost S&P 500 index fund [similar to an ETF]. I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”

Updated on June 26th, 2019

YOUR FREE FINANCIAL PLAN

The best financial plan is also the easiest.
Build a plan today.

 

Start now